Reducing the Level of Unemployment Permanently - Essay Example

Reducing the Level of Unemployment Permanently Introduction Unemployment, or joblessness, occurs when individuals in a country are without work and are actively seeking work opportunities. The unemployment rate is thus a measure of the level of unemployment in a country and is calculated as a percentage (Taylor 2008). This prevalence in unemployment is calculated by finding the relation between employment and employment rates ratio of the employed labor force in a country. Countries usually experience high levels of unemployment during times of recession (Atkinson, 2008). As of 2012, 6 percent of the world’s labour force was out of employment (International Labor Office, 2012). This percentage was equivalent to 197 million individuals (International Labor Office, 2012). Economists propose various theories and approaches towards reduction of the level of unemployment in various countries. The Philips curve, non-accelerating inflation rate of unemployment (NAIRU), natural rate of unemployment and general supply-side economics will be discussed in relation to a reduction of the unemployment rate. Supply-Side Economics The concepts of supply-side economics developed and spread in the 1970s. These were a response to the Keynesian economic policy, particularly the failure of demand management in the stabilisation of the western economies during periods of stagflation at the time. The distinguishing factor of supply-side economics as a modern phenomenon is the argument on a favour of low tax rates for the working class (Wessels, 2006). Classical liberals at the time opposed taxes and government. Their claim was that every individual had a right to their own self and their property, and thus taxation was immoral (Wessels, 2006). Supply-side economists, on the other hand, argued that the collective benefit of jobs provided individuals an impetus for cuts in tax. In supply-side economics, macro-economists argue that economic growth can be achieved in a country by the government reducing the barriers of production and enabling people to produce and supply goods and services, and also invest in capital (Wessels, 2006). According to supply-side economics concepts, consumers benefit from a high supply of goods and services at low prices (Atkinson, 2008). Furthermore, through investment and expansion of businesses, a country experiences an increase in the demand of employees (labour). Some of the typical policy recommendations for the concept are; less regulation, and low marginal tax rates to stimulate the production of goods and services (Atkinson, 2008). In supply-side economics, tax is viewed as a barrier to economic growth. According to Atkinson (2008), lowering of tax rates increases government revenue. The argument is that, with tax rates at the correct low levels, individuals can invest in assets. Increased investment causes a surge in the supply of goods. Employment opportunities are created with the increasing levels of supply (Atkinson, 2008). The supply-side economists’ argument is that supply stimulates demand (Atkinson, 2008). Supply-side policies for reducing unemployment With an application of various supply-side policies, the government of a country can successfully reduce the rate of unemployment. The government can for instance reduce the power of trade unions. Unions cause real wage unemployment when they bargain for wage rates that are above the market clearing level (Gottheil, 2013). Through reducing the influence of trade unions, a government can reduce the levels of real wage unemployment. Through education and training, the unemployed gain invaluable skills that enable them find job opportunities in the developing industries (Gottheil, 2013). An example is the training of unemployed steel workers in basics of IT to enable them work in the service industry. This strategy may, however, take many years to materialize and reduce the level of unemployment as the long term unemployed individuals may be unwilling to learn new skills. Improvement of labor market flexibility may ultimately reduce the levels of unemployment. Researchers argue that the high structural rate of unemployment in Europe is a result of restrictive labour markets (Gwartney, 2009). These restrictive labour markets discourage firms from employing workers. For instance, the abolishing of minimum working periods will make it easier for firms to hire and fire workers thus creating job opportunities (International Labor Office, 2012). However, it is important to note that the increased labor market flexibility may result to a rise in temporary employment and increased job insecurity. Improved geographical mobility is an answer to the reduction of unemployment rates. Taylor (2008) notes that often, unemployment is concentrated in particular regions. The government can overcome this geographical unemployment by giving firms tax breaks for every subsidiary set up in the depressed areas. Such a move will stimulate both growth of companies and reduce the rate of unemployment. The government can also offer financial assistance to workers who move from the unemployment regions to regions of high employment. An example is helping with payment of rent for employees who move to London. The Philip’s curve The Philip’s curve proposes that there exists an inverse relationship between the rate of inflation and the unemployment rate (Gwartney, 2009). This proposal suggests that it is the choice of policy makers to prioritize the management of either inflation or the rate of unemployment (Gwartney, 2009). The Philip’s curve was popular in the 1950s and 1960s when the suggestion was that the rate of economic growth and inflation could be influenced by policy makers through monetary and fiscal policies. For instance, if the level of unemployment is high and the level of inflation is low, policy makers could then stimulate aggregate demand. This move would reduce unemployment but cause an increase in the rate of inflation. The diagram below shows the relationship between the rate of inflation and the rate of unemployment. Diagram 1: Philip’s curve Source: http://www.economicshelp.org/blog/1364/economics/phillips-curve-explained/ Monetarists have, however, been critical of the trade off proposed by the Philip’s curve. The monetarists view is that in the long-run there exists no trade off as the long run aggregate supply is inelastic (Mankiw & Taylor, 2006). Therefore, if there is an increase in the aggregate demand, workers in firms will demand higher wages. When employees receive higher nominal wages, they then work for more hours as they feel that there is an increase in the real wages (Mankiw & Taylor, 2006). The price expectations are based on the previous year. However, an increase in the aggregate demand causes inflation. Therefore, the real wages remain the same in value (Mankiw & Taylor, 2006). When the workers realize that the real wages are the same as they were in the previous year, they change their price expectations and no longer supply extra labour. The real output, therefore, returns to the original level. Subsequently, the level of unemployment remains unchanged while the higher inflation rate is maintained. The short-run Philip’s curve, therefore, shifts upward from SRPC 1 to SRPC 2 as illustrated in diagram 2. Diagram 2: The long-run Philip’s curve Source: http://tutor2u.net/economics/content/topics/unemp/nairu.html Natural rate of unemployment The natural rate of unemployment is the rate of unemployment when the labor market is in an equilibrium state (Domitrovic, 2011). This is the rate of unemployment where the real wages have found a free market level. It the point at which the aggregate supply of labour balances with the aggregate demand of labour (Domitrovic, 2011). At the natural rate, all individuals willing and able to work at the prevailing market rate have found jobs and thus there is no involuntary unemployment in the country. However, there remains voluntary unemployment as there exist a few individuals remaining jobless while seeking for jobs offering better conditions and higher real wages. Consider the diagram below where the real wage rate is W1 and E1 workers are employed. At the present prevailing rate, however, the employed labour force is less than the total labor force. The natural rate of unemployment (AB) consists of both structural and frictional unemployment. To reduce the natural rate of unemployment, the government may adopt measures that will bring down the horizontal distance between the labour force and supply of labour curve. Diagram 3: Relationship between real wage rate and employment Source:http://tutor2u.net/economics/revision-notes/a2-macro-natural-rate-of-unemployment.html The gap can successfully be narrowed by an adoption of any supply-side policy that increases the number of individuals of working age and qualification willing to work in the labour market. These policies cause a shift in the labor supply to the right conversely narrowing the gap. This is illustrated in the second diagram below. Diagram 2: Relationship between real wage rate and employment Source:http://tutor2u.net/economics/revision-notes/a2-macro-natural-rate-of-unemployment.html To reduce the natural rate of unemployment, a government should focus on the reduction of labor market imperfections (Domitrovic, 2011). A government wanting to achieve a lower equilibrium rate might engage in a reformation of the system of welfare benefits thereby reducing the poverty trap. A poverty trap is a situation in which individuals find themselves in a poverty trap in which they see no value in getting a job. A government can also reform trade unions to reduce their collective bargaining powers as aforementioned. Adoption of a much relaxed approach to labor migration may also help in filling job vacancies. In general, a relaxation of the employment laws to reduce the cost of doing business in a country will lead to the willingness of businesses employing more individuals and increasing their workforce (Domitrovic, 2011). In addition, reduction of income tax will stimulate incentives of investment from the individuals’ thereby stimulating supply of goods and services and ultimately job creation. Non-accelerating inflation rate of unemployment (NAIRU) The non-accelerating inflation rate of unemployment (NAIRU) refers to the specific level of unemployment that is existent in an economy that does not cause any increase in the level of inflation (Cross, 1995). NAIRU usually represents equilibrium between the labour market and the state of the economy. At times, NAIRU is referred as the long-run Philip’s curve (Cross, 1995). For instance, if the level of unemployment is at 5 percent and the rate of inflation is at 2 percent, then assuming the values remains constant for a period of years, it can be concluded that when the level of unemployment is under 5 percent, then it is natural for the country to record a corresponding inflation rate of 2 percent (Cross, 1995). Critics, however, cite that it is unlikely for a country to record a static rate of unemployment that will last for very long periods of time (Atkinson, 2008). This is because the different levels of factors that affect employees and workforce, such as trade unions, can cause a quick shift of the equilibrium. Friedman proposed that at any particular labor market, there must exist a given level of unemployment such as frictional unemployment or classical unemployment. Frictional unemployment is associated with the change of jobs by individuals while classical unemployment is caused by individuals forfeiting employment due to real wages being lower than the market clearing levels (Atkinson, 2008). The level of unemployment may fall below the natural rate due to a temporary depression of the real wages as a result of unexpected inflation. This effect, however, would dissipate once the inflation expectations are corrected (Cornwall & Cornwall, 1993). Maintenance of the natural rate would only be possible when there is continuous accelerating inflation. According to Ostrup (2000), the analysis supporting NAIRU was very controversial. Empirical evidence suggested that there was a variance of the natural rate over time. This variance could not be explained easily by structures of changes in the labour market. The resultant effect was the adoption of the term “natural rate” to refer to the rate of unemployment below which the level of inflation would accelerate. This term does not, however, imply any commitment to any specific theoretical explanation, or provide a prediction that this rate would gain stability over time. Conclusion Unemployment is a challenge that the governments of all countries strive to fight. With high rates of unemployment and corresponding inflation, the citizens of a country usually live under depression. Governments use various policies and measures to curb and reduce the level of unemployment in their countries. Through supply-side economics, the governments try to solve the levels of unemployment by borrowing from the concepts of supply-side economists. Their main aim is increasing the supply of goods. In a supply-side view, demand is a secondary objective and not a primary one. Application of supply-side economics may solve the unemployment challenge, but prove insufficient to work alone. An approach of both supply-side and demand factors in solving unemployment crisis may prove helpful to a country. It is, therefore, the role of the government to devise the best ways of solving unemployment in their country in order to reduce the levels of unemployment permanently. References Atkinson, R. D. (2008). Supply-side follies: why conservative economics fails, liberal economics falters, and innovation economics is the answer. Lanham, Rowman & Littlefield. Cornwall, J., & Cornwall, J. (1993). Economic breakdown and recovery: theory and policy. Armonk, N.Y., M.E. Sharpe. Cross, R. (1995). The natural rate of unemployment: reflections on 25 years of the hypothesis. Cambridge, Cambridge Univ. Press. Domitrovic, B. (2011). Econoclasts: the rebels who sparked the supply-side revolution and restored American prosperity. Wilmington, Del, ISI Books. Gottheil, F. M. (2013). Principles of economics. Mason, OH, South-Western Cengage Learning. Gwartney, J. D. (2009). Economics: private and public choice. Australia, South-Western Cengage Learning. International Labor Office (2012). Global Employment Trends 2012: Preventing a deeper jobs crisis. Retrieved From: http://www.ilo.org/wcmsp5/groups/public/@dgreports/@dcomm/@publ/documents/publication/wcms_171571.pdf Mankiw, N. G., & Taylor, M. P. (2006). Economics. London, Thomson. Ostrup, F. (2000). Money and the natural rate of unemployment. New York, Cambridge University Press. Taylor, J. B. (2008). Economics. Boston, Mass, Houghton Mifflin. Wessels, W. J. (2006). Economics. Hauppauge, N.Y., Barrons. Read More